J

Jointly controlled entity

A joint venture which involves the establishment of an entity to engage in economic activity, which the Group controls jointly with its fellow venturers

L

Level 1

Fair value is determined using observable inputs that reflect unadjusted quoted market prices for identical assets and liabilities, for example exchange-traded commodity contracts valued using close-of-day settlement prices. The adjusted market price used for financial assets held by the Group is the current bid price

Level 2

Fair value is determined using significant inputs that may be either directly observable inputs or unobservable inputs that are corroborated by market data, for example over-the-counter energy contracts within the active period valued using broker-quotes or third-party pricing services and foreign exchange or interest rate derivatives valued using market-based data

Level 3

Fair value is determined using significant unobservable inputs that are not corroborated by market data and may be used with internally developed methodologies that result in management's best estimate of fair value, for example energy contracts within the inactive period valued using in-house valuation techniques

LNG

Liquefied natural gas

M

mmboe

Million barrels of oil equivalent

mmth

Million therms

MWh

Megawatt hour

N

NBV

Net book value

NGO

Non-governmental organisation

P

PP&E

Property, plant and equipment

PRT

Petroleum revenue tax

R

ROC

Renewable obligation certificate

RPI

Retail Price Index

S

Securities

Comprised of Treasury gilts designated at fair value through profit or loss on initial recognition and available-for-sale financial assets. The fair values of securities are based on quoted market prices, when available. If quoted market prices are not available, fair values are estimated using observable market data

SCT

Supplementary charge associated with UK Corporation Tax

Spark spread

The difference between the price of a unit of electricity and the cost of the gas used to generate it

Chief Executive's Review

2011 was a tough year, both for Centrica and our customers. But the strength of our integrated business and balance sheet means we've been able to take the lead in helping customers through these difficult times, as well as delivering growth and making the investments on which Britain's energy future depends.

Centrica faced very difficult market conditions in 2011. Sharply rising wholesale commodity prices in the first half of the year meant that the UK residential energy supply business had become loss making, necessitating a significant increase in retail tariffs in August. Record mild weather, both in the Spring and in the Autumn, led to a 21% reduction in average household gas consumption and a 4% fall in average electricity consumption. As a result, the average domestic customer bill was some 4% lower in 2011 than the year before, despite the increase in unit prices. The squeeze on household disposable income has also put pressure on our residential services business, with customers deferring discretionary spending, especially on new central heating systems.

Upstream in the UK, the business delivered higher profits. This reflects good operational reliability from our assets and the effect of higher commodity prices, with a much improved performance from the nuclear fleet in particular. However, market conditions remained difficult for our gas-fired generation and gas storage businesses. In addition, the unexpected increase in upstream taxation announced in March reduced our upstream earnings. It also, unfortunately, came at a time when the UK needs to offer a stable tax regime if it is to attract the investment required to meet the country's future energy needs.

In North America, we delivered significantly higher operating profits, reflecting both the operational improvements we have made and the contribution from acquisitions. Direct Energy provides a strong platform for growth, using our expertise in deregulated markets to add scale upstream and downstream, where we see attractive opportunities.

Despite the difficult economic and political backdrop, which resulted in the business incurring a number of exceptional charges, we are pleased to have delivered further adjusted earnings growth, following a very strong result in 2010. Throughout the challenges faced during the year, we have demonstrated the resilience of the Centrica integrated business model. In addition, the total value of our commitments to secure gas for the UK now stands at more than £50 billion. We can only shoulder responsibilities on this scale with the financial security provided by our growing upstream asset base and a profitable downstream business.

STRATEGIC PRIORITIES AND DIRECTION UNCHANGED

Health and safety is our first priority – a message reinforced through regular management communication, operational practice, corporate policy, procedures and reward structures. During the year, we further strengthened our procedures around both customer safety and process safety and achieved a 42% reduction in our lost time injury frequency rate to 0.25 per 100,000 hours worked.

In these tough economic conditions, we remain focused on maximising the returns from our existing assets, while taking a disciplined approach to investment. We will also maintain a healthy balance between upstream and downstream activities as well as across generation types and geographies. Centrica remains, at its heart, a customer facing business.

Upstream, we continue to focus on reliability, both in gas and oil production and in power generation; and we are making good progress on our investment programme, deploying our expertise to bring new projects on line. We are now widely recognised for our expertise across the energy value chain and have entered into strategic partnerships with other leading players in their field – in gas and oil, in offshore wind and in nuclear. In December we announced an intention to increase our upstream gas and oil production by 50% to 75 million barrels of oil equivalent (mmboe) per annum and to treble our offshore wind capacity, retaining investment options in new nuclear, biomass, new build CCGT and gas storage.

Downstream, the priority is to maintain the efficiency of the business and to benefit fully from our scale and brand, while maintaining high levels of customer service. In North America, we continue to increase the scale of the business, through organic growth and through acquisitions in key competitive markets. We are making good progress towards our goal of doubling the profitability of the business by 2014, seeking further opportunities for growth where we see value, both upstream and downstream.

Given the need to remain competitive in all our divisions, we are undergoing a Group-wide process to sharpen the business for the benefit of our customers and our shareholders. We expect to deliver £500 million of cost savings over the next two years, allowing us to continue to invest for further growth within the existing cost base. The programme to identify efficiencies is already well under way, and we expect to realise around half of these savings in 2012. As part of these measures, we have taken out 2,300 roles across the business and implemented a pay freeze across much of the Group, including the Board; however, we remain committed to investing in the skills and the people we need to achieve our growth ambitions.

We are making good progress on our capital investment programme, and expect to spend a further £1.4 billion on organic investment in 2012, with around half in the upstream gas and oil business

HONEST CONVERSATION

During the year, the energy supply sector faced increased regulatory and political scrutiny, as well as uncertainty surrounding Ofgem's proposals for retail market reform. We led the way in taking measures to help build customer trust by making the purchase of gas and electricity simpler, more transparent and fairer for consumers. We have simplified our tariffs and have also written to each of our customers, inviting them to check that they are on the most appropriate tariff. We are setting out the facts about energy prices, providing each customer with a breakdown on their bill of the actual costs of providing the energy they consume. We have also made sure that our most vulnerable customers receive the £120 Warm Home Discount, with the widest eligibility criteria of any major supplier.

However, there is still much to be done before consumer confidence can be fully restored. This will mean being much clearer about the cost of producing and providing energy to the customer's home, the rising cost of green levies, the impact of growing international demand for gas and the profits the industry makes. All of us – the industry, the Government and the Regulator – have a vital role to play in fostering an honest debate about energy, with affordability now a key issue for our customers.

In January 2012, we were the first of the major energy suppliers to implement a price reduction, with an immediate 5% cut in our standard electricity tariff. Nonetheless, the longer-term trend in wholesale energy prices and non-commodity costs remains upwards. That is why the work we are doing to help customers take control of their energy usage is so important – including free loft or cavity wall insulation, a free home energy survey and leading the way on the installation of smart meters for all our customers.

All of us – the industry, the Government and the Regulator – have a vital role to play in fostering an honest debate about energy, with affordability now a key issue for our customers.

Sam LaidlawChief Executive

2011 INVESTMENT

We invested £1.6 billion of capital in 2011 across the Group, mainly in upstream gas and oil, in power generation and in North America. We have also already announced a further £1.4 billion of acquisitions which are expected to complete in 2012.

Upstream, expenditure included investment in our Ensign and York projects and our ongoing exploration programme. Construction of the Lincs offshore wind farm is making good progress and work is ongoing on new nuclear, prior to a final investment decision. In North America, we have made significant progress in growing the scale of the business both upstream and downstream, increasing our gas and liquid reserves by 14% and adding over 750,000 customers in our core growth markets, Texas and the US North East.

Building the geographic diversity of our asset portfolio is a key priority, and an increasing proportion of our investment now falls outside the UK. In November, we announced a new 10-year supply contract with Statoil and the acquisition of a package of Norwegian gas and oil assets. This marked a significant step change in the scale of our business, both in terms of production volumes and development opportunities, as well as forging a long-term working relationship with one of the leading players in the Norwegian market. Already in 2012, we have announced further upstream investments to increase our share in the Norwegian Statfjord field and acquire a package of UK North Sea assets from Total, providing further gas reserves for our customers.

Centrica is now seen to fill a key role on the global energy stage, enjoying close working relationships with major partners: in LNG, in nuclear, in offshore wind and in upstream gas and oil. At a time when many British companies are reluctant to invest because of economic uncertainty, we are deploying our capital to generate growth and returns for shareholders.

FUTURE INVESTMENT

Significant investment decisions lie ahead, both for the UK and for Centrica. It is vital that the Government provides the clarity and assurance that will be needed if the industry is to step up and deliver the massive investment – an estimated £200 billion in total by 2020 – that the country requires to secure its energy future and build a low carbon power industry.

Following the publication of the UK Government's White Paper on Electricity Market Reform, there remains much detail to be resolved to ensure the right framework for investment. We also look to the Government to explain the importance of these investments to the country, balancing energy security, environmental goals and crucially, affordability, for this generation and for generations to come.

The Regulator too has a vital role to play in ensuring that the UK offers a stable and attractive investment climate, both in the upstream and the downstream. The proposed retail market reforms need to encourage investment in propositions for customers and smart meter technologies to improve energy efficiency, reduce complexity and increase customer choice.

The combination of strong cash flows and an attractive range of investment opportunities is a key attribute of the Centrica business model – with options to invest across the energy value chain and in different geographies, to deepen our customer relationships and secure the energy requirements of the Group for the future. We will only deploy capital where we see a strong strategic fit, together with attractive returns commensurate with the risks being undertaken.

OUTLOOK

As we look ahead, the external environment remains challenging. However, the past year has shown our business model to be robust, delivering year-on-year growth in a very difficult trading environment. Against this backdrop, we are taking positive action to sharpen our activities, with Group-wide initiatives already in progress to reduce costs and maintain our competitive edge. We are successfully bringing new investment projects on-stream, and will begin to see a contribution from recent acquisitions as we integrate them into our portfolio. Overall, we plan to deliver improved year-on-year adjusted earnings growth in 2012, subject to the usual variables of weather patterns and commodity price movements, although we continue to face some of the same headwinds as in 2011, in particular the effects of continued economic pressure on household and business budgets.

Downstream in the UK, we expect further progress in residential services, together with a positive contribution from our new energy activities. In the highly competitive market for residential energy supply, the outcome, as ever, depends on wholesale prices and the weather. In our Upstream UK business, we will progressively benefit from the higher wholesale commodity price environment, although the outlook for gas-fired generation remains weak and market conditions for new gas storage projects remain challenging. We will also benefit from the recently acquired gas and oil assets in the Norwegian and UK sectors of the North Sea. In North America, we expect to see the positive effect of organic improvements in the business, together with a contribution from recent acquisitions, both upstream and downstream. However, we continue to see customer losses in the Ontario energy supply business, as the regulatory environment has become less conducive to competition.

We are making good progress on our capital investment programme, and expect to spend a further £1.4 billion on organic investment in 2012, with around half expected to be in the upstream gas and oil business. This is in addition to the £1.4 billion already committed for the Statoil assets, the additional stake in Statfjord and the package of UK North Sea assets from Total. In the coming year, we expect the Ensign, Seven Seas, Rhyl and Atla fields all to produce first gas and our Lincs offshore wind farm to generate first power. We also expect to make a final investment decision on the development of the Cygnus gas field towards the middle of 2012, with a decision on the Race Bank offshore wind project expected around the end of the year, in each case subject to appropriate returns. On new nuclear, a final investment decision on Hinkley Point C is targeted for the end of 2012, although much remains to be achieved before this decision can be taken and the economics must prove to be sound. In gas storage, our Caythorpe project remains on hold and we continue to assess the Baird project.

In summary, the Centrica business model remains resilient, underpinned by strong cash flows and an attractive pipeline of investment projects. The business is well placed for the long term and we will continue to improve the service offering for our customers, both in the UK and North America. We will also drive further cost savings across the Group to enhance our competitiveness, and deliver increasing value through the efficient deployment of capital, in order to continue to enhance returns for shareholders.

Sam LaidlawChief Executive
23 February 2012

Progress on our strategic priorities

How we're delivering our vision to be the leading integrated energy company in our chosen markets.

Strategic priority 1

Growing British Gas

Despite a reduction in operating profit*, British Gas delivered a solid financial performance in 2011 in challenging market conditions, underpinned by our scale, our service and our drive for innovation.

* Including share of joint ventures and associates before interest and taxation, and before depreciation of fair value uplifts to property, plant and equipment from Strategic Investments and exceptional items and certain re-measurements.